Aviva Investors: COVID-19: This time is different?

03 Apr 2020,  Euan Munro 

While the COVID-19 pandemic may be unlike anything financial markets have experienced before, the past still offers valuable lessons for investors trying to make sense of the crisis, explains Euan Munro.

As someone who has worked in the financial markets for a few decades, it can be hard not to lapse into the mindset of thinking you’ve seen and heard it all before. Knowing history tends to repeat itself can be helpful for fund managers, particularly when looking for the warning signs that precede a crisis so that they can take the necessary steps to protect client portfolios.

In the lead up to the global financial crisis, I wasn’t alone in having concerns about the price of corporate credit and the explosion of structured credit long before the bubble burst in late 2007. Far from being a black swan event that came out of nowhere, there was just cause for anticipating credit would be at the heart of the next crisis, and so it proved.

Looking back at other turbulent episodes during my career, there were similar grounds for concern: the dot.com bubble was an accident waiting to happen as capital blindly flowed into businesses without any track record or viable business model; while the overreliance of Asian corporates and governments on offshore debt for funding in the late 1990s was a source of structural fragility that very quickly tipped the region into crisis.

When you know the main risks, you can at least face into a crisis in a position of relative strength, even if few will emerge from such periods unscathed. The COVID-19 pandemic is not, however, like any crisis we have experienced before. We did not see this coming; I certainly don’t remember reading any research or newspaper articles heading into 2020 predicting that a pandemic would spread rapidly around the world, causing severe restrictions on social movement and a near shutdown of economic activity in all but a few industries.

All financial crises have a human cost; what makes this one unique is that it is a human crisis that has triggered a significant economic and financial shock, rather than the other way around. It is also unique in the respect that, regardless of which sector we work in, we all have to navigate our way through it while worrying about the health of our loved ones and ourselves. Many of us are also taking responsibility to help more vulnerable members of our communities.

At times like these, the ups and downs of financial markets might seem trivial. But when you manage other people’s money, it is also at these times that we must work even harder to ensure our investment processes are robust and our decisions based on a rigorous analysis of the risks we face. In the very near term, protecting client assets is our absolute priority: irrespective of whether we saw this crisis coming, capital preservation is a matter of design, not luck. That’s because one of the most important roles of an asset manager is to construct portfolios for a variety of futures, even those that never materialise.

During good times, positioning strategies for the very worst-case scenarios might appear wasteful, and some might argue over-elaborate. But for events like the global financial crisis or COVID-19, the effort to make portfolios as watertight as possible bears out, especially when there is so much we don’t know. We can’t, for example, predict accurately when the spread of the pandemic will be contained, never mind when it will be in decline or when restrictions on people’s movement will be lifted. Until the health risks have eased materially, assessing the effectiveness of the policy response by governments and central banks to support economies and stabilise financial markets is pure guesswork.

I’ve been somewhat surprised in the past week to read confident predictions from seasoned investment professionals calling the bottom of the sell off. Again, assessments on the depth or duration of a crisis cannot be made with precision and are not issues I encourage our teams to spend any time on. What I am encouraging them to do is to look through the short-term uncertainty and identify sustainable, long-term opportunities where markets, in this time of crisis, are pricing assets wrongly.

The cause of this crisis may be different to ones we have seen in the past, but what I can say with a reasonable degree of confidence is that the dislocations in asset prices caused by fear rather than fundamentals is no different. This will create opportunities.

We know there will be extraordinary monetary and fiscal support globally; perhaps dwarfing the response to the global financial crisis and the sovereign debt crisis in Europe. Structural shifts that were taking place across different industries may be accelerated. The crisis could also prove a watershed moment for the ‘S’ in ESG, as investors and governments exert more pressure on companies to take their social responsibilities seriously.

A repricing of risk by investors is also likely: at an enterprise level, we must make sound decisions on which companies have sustainable business models and which look vulnerable; similarly, at a macro level we need to work out the economies that will be most resilient in the aftermath of this crisis so that we can make appropriate asset allocation decisions on rates and currencies.

Such choices will influence our investment performance for the next two to three years. Just as preserving capital is not a matter of luck but design, how we exit this crisis will not be about luck, but about skill and judgement in assessing where the biggest inefficiencies are and positioning our portfolios accordingly. There will be difficult days and weeks ahead, but they will pass. We need to be ready for whatever materialises when they do.

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